Business Education: Investments Basics

Securities
Securities are financial assets that can be traded.
These investments include many different types, such as stocks and bonds, and are not tangible items. Bonds and banknotes are two common types of debt securities. With debt securities, the investor is the lender. Equity securities are stocks in which the investor purchases a small portion of a company. Securities are advantageous because they can provide a great deal of return on an investor's money. A disadvantage is that they often involve risk.
With some of them, an investor can lose everything. Securities range in both risk and return; in general the greater the risk, the greater the potential for a large return. Investors may get a certificate or an electronic form.

Stocks
Stocks are a common form of investment in which investors purchase a very small amount of a company. The returns they generally see are from rising stock prices when the company is doing well. Sometimes the company pays dividends as well. Stocks can be advantageous in that there is no limit to what someone can make. If they choose a stock in a company that skyrockets, they can literally make a fortune on what started as a small investment. The downside is that there can be a lot of risk. Just as the stock price can rise dramatically, it can also fall dramatically and become practically worthless. Thus, an investor could lose everything. Some stocks are riskier than others, and diversifying stock lowers the risk.
Stocks change in price minute to minute, and you pay a commission to buy or sell. Common stocks offer a chance to hit it big if the price skyrockets. Since common stockholders are actually owners of the company, they will receive their prorated share of the earnings and dividend income only after the company's other obligations have been met. Common stockholders need to be aware that it is possible no return on investment is a possibility.
Bonds are a type of long-term debt; when you purchase bonds, you are a creditor of the company and that company pays you back over the life of the bond. Stocks provide higher rates of returns than bonds but they are far less stable. Additionally, bonds stabilize and diversify a portfolio. People who hold common stock have ownership or equity position whereas bondholders do not.

Bonds
Bonds are publicly traded IOUs in which the bondholders lend money to the issuer of the bond. Investing in bonds is popular because they can provide a high current yield and can generate substantial gains when market interest rates fall. Bonds can be used aggressively for individuals who actively seek capital gains, and conservatively for individuals who seek high current income. Due to the high quality of bond issues, they may also be used for the long-term preservation and accumulation of capital.
Investing in bonds means an investor is loaning money to an institution, which is the borrower. In exchange, the borrower is providing the investor (or lender) with a coupon or premium. Thus, the investor will get money for lending money. In addition, when the bond reaches maturity, its face value will be given back to the investor. The advantage of bonds is that they are a less risky form of investing than many other methods such as stocks. Most of the time, investors receive the money they are promised. The disadvantage is that the return does not generally have the potential to be as great as with stocks. While stocks can return an almost unlimited amount, bonds are limited greatly. They offer less risk, but less reward. Many people invest in a combination of bonds and stocks.
A single issuer of bonds can have many bonds outstanding at a time. While bonds can be differentiated from one another due to maturities and coupons the kind of collateral behind them also distinguishes them. Bond issues are either senior or junior standing, with senior bonds being backed by a legal claim on the issuer's specific property. This claim acts as the collateral for the bonds. Senior bond issues include mortgage bonds (secured by real estate) and equipment bonds (secured by certain types of equipment and favored by airlines and railroads). Junior bonds are only backed by the issuer's promise to pay interest and principal in a timely manner; there is no collateral.

Segments of the Bond Market
The four segments of the bond market are the treasury, agency, corporate, and municipal. Treasury bonds were created by the U.S. Treasury to help meet the federal government's ongoing needs, have a maturity of more than ten years and pay interest twice a year. Agency bonds are issued by divisions of the U.S. government and usually provide higher yields than Treasury bonds. Corporate bonds are issued by corporations, and can come in the form of industrials, public utilities, rail and transportation bonds, and financial issues. Municipal bonds are issued by states, counties, cities, and other government divisions, and unlike other bonds, their interest income is federally tax free.

Sinking Fund
A sinking fund is the pool of money set aside by a business or the government to repay a bond issue over time. How the bond will be paid off is important to investors. Some bonds specify the yearly repayment schedule as well as how much principal will be retired each year. Sinking funds usually start one to five years after the issue date and continue each year thereafter until the issue is all or mostly paid off.

Call Features
A call feature specifies whether a bond can be retired before its scheduled maturity date, and if it can, under what conditions. There are three main types of call features: free call, noncallable, and deferred call. A freely callable bond can be retired early. A noncallable bond means the issuer cannot retire the bond before it matures. A deferred call keeps the bond from being retired until after a certain period of time passes from the date of issue, meaning the issue cannot be retired during the deferment time but becomes available for retirement thereafter.

Convertible Bonds
Convertible bonds are only found in the corporate market and have features of both corporate bonds and common stocks. They are issued as unsecured, but are allowed to be converted into a particular number of shares of the issuing company's stock during a certain time period. A convertible issue has a conversion privilege that accompanies it, and this clearly states the conditions and specific nature of the conversion feature, such as exactly when the bond can be converted. The conversion ratio states the number of shares of common stock that the bond can be converted into.

Bond Rating System
Bonds receive letter grades for their investment quality and these bond ratings are widely understood and used in the corporate and municipal bond markets. Two of the best known rating agencies are Moody's and Standard & Poor's. When a new corporate or municipal issue appears on the market, professional bond analysts calculate both its default risk exposure and its investment quality. The issuing organization's financial records are looked at carefully and its future prospects assessed. This allows a bond rating to be assigned that is indicative of how quickly and efficiently the issuing organization will repay its debt. Once after a new issue is rated, it is not finished: outstanding, older bonds are reviewed regularly to make sure their assigned ratings are still valid.

Pricing of a Bond
Figuring the fair price of a bond is known as bond valuation. Theoretically, the value of a bond is calculated using the present value relationship, or the cash value it would be expected to generate.
Pricing the bond is done by determining the appropriate discount rate. Once the pricing and its relative sensitivity has been estimated, the yields and coupons can then be determined. In corporate and municipal markets, bonds are priced in decimals. Treasury and agent bond quotes are given in thirty-seconds of a point, with1 point equaling $10.

Mutual Funds
A mutual fund is an investment strategy in which money is collected from many investors and professionally managed. The fund manager trades the collected money, investing it in bonds, stocks, short-term money market accounts and other investment vehicles. Any net proceeds or losses are paid out to the investors on a yearly basis. Mutual funds are a popular investment choice for individuals because they offer a number of investment opportunities and services that are appealing to investors. Mutual funds are one of the three basic types of investment companies in the United States (the other two are unit investment trusts and closed-end funds).
Mutual funds are businesses that take money from a variety of investors and put it in a portfolio of bonds, stocks, securities, and assets. Each mutual fund has a different combination. A person who buys into a mutual fund will hold a portion of ownership of the portfolio and reap the rewards when the portfolio gains value. The idea is that an investor enjoys the benefits of diversification by not investing in one single asset. There is risk involved with mutual funds—they can lose value—and there are fees and other costs that can lower the value. The government does not guarantee them. Some are riskier than others, depending on the combination of the portfolio. Still, they are a good way to balance risk and reward and are a popular retirement and investment option.
Mutual funds can invest in several types of securities with the most common being cash instruments, bonds, and stock although there are a lot of other categories. Sector funds are any stock funds invested primarily in a particular industry's shares, like technology. Both stock and bond funds can invest in mainly U.S. securities (domestic funds), U.S. and foreign securities (global funds), or foreign securities (international funds). Bond funds differ according to their risk, issuers type (e.g., government agencies, corporations, or municipalities), or maturity of the bonds
(short- or long-term).
Mutual funds are subject to a special set of regulatory, accounting, and tax rules. Unlike most other types of U.S. businesses, mutual funds are not taxed on their income as long as 90 percent of it is distributed to shareholders and the funds meet certain diversification requirements as set by the IRS. Also, the earnings from mutual funds usually do not change as it passes on to the shareholders. Mutual fund distributions are tax-free to the shareholder if they are tax-free municipal bond income. Depending on how the mutual fund earned the distributions, taxable distributions are either ordinary income or capital gains. (Net losses are not distributed or passed through to the investors of mutual funds.)

Fund Manager
Professional fund managers try to choose investments they think will align with the purpose of the fund's investment, predict the future performance of chosen investments, oversee cash flow for mutual funds, and constantly adjust the mutual funds' investment portfolios. The fund manager is hired by a management company to administer the fund, and this company can also fire the manager. Fund managers charge a fee for their services, and this fee is a percentage of the fund's average assets during its management. A fund can be managed by one person, by two people who act as co-managers, or by a team of three or more people. When looking for a fund manager, look for someone with a history of long-term, consistent fund performance.

The Economist
The Economist is an authoritative weekly newspaper that provides anonymous (collaboratively written) opinions and analysis of business and finance. It is a good, objective financial resource to consult when investing. It covers the latest world and American stock indices as well as commodity prices, live stock prices, intraday and historical stock charts, financials for numerous companies, weekly economic and financial indicators, currency information, and rankings and ratings. A weekly economic statistics feature addresses items such as employment statistics as well as special statistical features.

The Wall Street Journal
The Wall Street Journal is a newspaper that primarily covers national and international business and financial news and issues. Sections include marketplace (which covers health, technology, media, and marketing industries), money and investing (which covers and analyzes international financial markets), economic issues, and personal investments. Its personal investments section has such regular columns as Cheapskate, The Intelligent Investor, Deals and Dealmakers, Fundtrack, Investing, Marketwatch, Tip of the Day, Starting Out, Encore, Reinvent, Ask Dow Jones, Common Sense, and Family Money, which can be quite helpful to an individual doing personal financial planning.